ECB leaves rates unchanged, sees gradual recovery

By David Mchugh
Associated Press

Published: Wednesday, June 6 2012 12:00 a.m. MDT

FRANKFURT — The European Central Bank has left its benchmark interest rate unchanged as it increases the pressure on eurozone leaders to tackle a government debt crisis that threatens the global economy.

The decision Wednesday by the bank's 23-member governing council left the refinancing rate at a record low 1 percent.

The bank is under pressure to stimulate a weakening economy of the 17 countries that use the euro with a rate cut. But Bank President Mario Draghi undermined any hopes of a cut by sticking to the bank's earlier forecast for a gradual recovery this year.

He said that growth "remains weak, with heightened uncertainty weighing on confidence and sentiment" and cited "downside risks" to growth.

The eurozone faces trouble on several fronts. Spain is struggling to bail out banks that made reckless loans during a real estate boom and are now suffering mounting losses. Greece, already rescued by expensive bailout loans from the other countries, faces elections June 17 that could result in rejection of the strict cutbacks demanded under its bailout. That could lead to a chaotic exit from the euro.

Trouble in one place could spread to other countries in the form of investors selling assets and bank customers withdrawing deposits for fear banks will collapse or their savings will be redenominated in a new currency after euro exit. Finance ministers from the Western industrial countries held a conference call Tuesday to discuss the eurozone crisis.

A renewed financial crisis in Europe could hurt growth in the United States and Asia by creating losses and fear among banks, which are key to the functioning of the global economy, and by hurting trade.

Some of the eurozone's problems, however, were beyond the reach of central bank action such as rate cuts or loans to banks. The ECB has already taken strong action to stimulate credit and borrowing by cutting rates to record lows and loaning €1 trillion in emergency credit to banks.

Borrowing has yet to pick up, Draghi said Wednesday, with some parts of the European financial system have plenty of liquidity, or access to borrowing and cash by banks, while others don't, he said. That was not the fault of the central bank, he said. The ECB has flooded banks with €1 trillion in cheap loans, yet credit and lending remain weak as businesses see no reason to borrow.

"There is plenty of liquidity in some parts... and shortages in other areas," he said. "Some of these problems in the euro area have nothing to do with monetary policy. "

He said real interest rates were already so low as to be negative in inflation adjusted terms, given an inflation rate of 2.4 percent. He left the door open for more central bank action if things got worse, saying "we'll monitor closely all the developments and we'll stand ready to act."

Draghi told European politicians in Brussels last week that the euro's basic setup is "unsustainable" and urged them to sketch out a long-term vision for strengthening the euro's basic institutions over the next few years.

He repeated that call Wednesday, in response to a question about his expectations for a June 28-29 European Union summit. "What we all expect is a clarification of this vision, a path toward this objective with all the conditions that have to be satisfied to achieve this objective."

While it tries to squeeze more effort from government, the ECB is facing a weakening economy in the 17 countries that use the euro. Surveys of economic activity and business confidence have pointed sharply down, suggesting that the mild contraction of 0.3 percent predicted by the European Commission will turn out to be worse. That would argue for lower interest rates that would in theory make borrowing cheaper for businesses so they could expand and hire.

The measures to be discussed at the summit at the end of June could include further steps to increase growth, moves toward more control over national government's spending and some form of shared borrowing to reduce the chance that one country would default.

Most of those steps would take years to implement and several are highly controversial. Germany has resisted common borrowing through so-called eurobonds, afraid spendthrift countries would overborrow using its stronger credit rating. A plan for stronger control of countries finances might ease that objection, however.

Officials from the European Union's executive, the Commission, unveiled their legislative proposals earlier Wednesday designed to strengthen the eurozone's ability to restructure troubled banks. However Wednesday's proposals, not expected to come into power until 2018, fall short of the full banking union pushed for by some European officials.